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6 Things Every Non-Spouse IRA Beneficiary Needs to Know

By Sarah Brenner, JD
IRA Analyst
Follow Us on Twitter: @theslottreport
 

It is not unusual to inherit an IRA from someone who is not your spouse. Many people inherit an IRA from a parent or a sibling. If this is the case for you, here are six things you will want to know.

1. Take some time. When you inherit an IRA, it is important that you don’t make any rash moves. Sometimes beneficiaries act too quickly and end up losing big tax breaks. For example, if you inherit a large IRA from your father and you immediately take a distribution of all the funds, you will likely be facing a large tax bill. Even worse news, you cannot undo this transaction. Take your time to investigate all your options carefully before doing anything with the inherited IRA funds. You may want to meet with a knowledgeable tax or financial advisor to be sure that you make all the right moves.

2. Inherited IRAs are different. When you inherit an IRA, it is not the same as having your own IRA. There is special titling required. The custodian must title the IRA in your name as beneficiary of the deceased IRA owner. This tells the IRS that it is an inherited IRA. You may not move inherit IRA funds into an IRA titled in just your own name.

3. Transfers are allowed. If you would like to move your inherited IRA to a new custodian, it is very important that you do it the right way. Do a direct trustee-to-trustee transfer to an inherited IRA with the new custodian.  Non-spouse beneficiaries cannot receive the funds and then do a rollover.

4. RMDs are required. You won’t be able to hold on to your inherited IRA forever. You will be required to take required minimum distributions (RMDs). This is true even for Roth IRAs where RMDs are not required while an IRA owner is alive. Failing to take an RMD can result in a pretty serious penalty. You will be hit with a 50% penalty on the amount of the RMD that is not taken.

5. Get the Stretch. You may be able to stretch required minimum distributions from your inherited IRA over your life expectancy. This is one of the biggest tax breaks available. Your inherited IRA can continue to grow for years as you only withdraw the RMD. To be able to take advantage of this important tax benefit you must be named as a designated beneficiary on the IRA beneficiary designation form. If you are inheriting the IRA through an estate, you are out of luck.

6. Uncle Sam’s Share. The tax consequences of taking a distribution from an inherited IRA will depend on whether it is a traditional IRA or a Roth IRA. Distributions from inherited traditional IRAs will be taxable unless the IRA owner had basis (after-tax funds) in the IRA. On the other hand, distributions from a Roth IRA that are qualified distributions will be tax-free. Any distribution from an inherited IRA will never be subject to the 10% early distribution penalty, regardless of the age of the IRA owner or the beneficiary. That is because there is an exception to the penalty for IRA distributions due to death.

 

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